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For example, if a stock price has a bid price of $100 and an ask price of $100.05, the bid-ask spread would be $0.05. The spread can also be expressed as a percentage of the ask price, which in this case would be 0.05 percent. What a bid-ask spread tells you
You may not have spent much time thinking about the bid-ask spread in , but it can have some informational value. Here’s what it means in different market situations. Wide markets
Markets with a wide bid-ask spread are typically less liquid than markets with a narrow spread. The spread widens because there aren’t high levels of supply and demand, or buy and sell orders to easily match up. The higher transaction cost, in the form of a higher spread, is compensation to the market maker for the illiquidity. Thin markets
Conversely, markets with a thin or narrow bid-ask spread are typically highly liquid and have plentiful buy and sell orders from traders. Widely traded stocks, such as , and , have narrow spreads because there is a high amount of supply and demand for their shares. It’s very easy for market makers to find a buyer or a seller in the stocks of these types of . Small-cap stocks or more obscure companies may have wider spreads due to the lack of investor interest. How a bid-ask spread relates to liquidity
Differences between bid-ask spreads from one security to the next, or even between asset classes, is because of the differences in liquidity between the assets. Within the stock market, you’ll typically see a wider bid-ask spread for small- or micro-cap stocks than you would for widely-followed that are very liquid. As you move from the stock market to the , liquidity may fall, despite the bond market being larger in overall size, causing bid-ask spreads to widen. You might also see wider spreads in securities with high volatility, because the market maker wants additional spread to compensate them for the risk that prices change. Most traders and professional investors , allowing them to choose the price they’re willing to buy or sell at, rather than placing a market order that is subject to the pricing at the time of the trade. Bottom line
The bid-ask spread is worth a close look when buying or selling a security, particularly if it’s an investment with low liquidity. Some assets such as large-cap stocks may have so much supply and demand that the spread is barely noticeable, while other securities such as micro-cap stocks or certain bonds may have spreads that make up a noticeable percentage of the asset’s price. SHARE: Bankrate reporter Brian Baker covers investing and retirement. He has previous experience as an industry analyst at an investment firm. Baker is passionate about helping people make sense of complicated financial topics so that they can plan for their financial futures. Bankrate senior reporter James F. Royal, Ph.D., covers investing and wealth management. His work has been cited by CNBC, the Washington Post, The New York Times and more. Related Articles